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Technical Comment:
Wednesday’s S&P 500 had large intraday swings ending the day barely changed, up less than 0.1%. This was on lower volume compared to Tuesday, but higher than the 30-day moving average. The Dow was barely up at the close of the market, and the Nasdaq was down almost 0.5%.

Subjective Comment:
The large intraday swings suggest the recent volatility has not fully subsided. Our automated forecast continues to predict growth, but it would be nice to see increasing prices on stronger volume. The following comments are on topics that could influence US markets in the coming days and weeks. (Frequent sources for our information include ZeroHedge and EconomicPolicyJournal.)

Bullish Factors:

US Money Supply continues to grow from the fractional reserve money multiplier. This will eventually drive price inflation and an up-trend in stock prices. It is difficult to predict when this up-trend will assert itself given bearish influences discussed below.

Recent economic data in the US suggests improvement. July industrial production was up 0.9% (better than expected) combined with an upward revision in the same for June, up to 0.4%. Manufacturing output in July rose 0.6% and total industrial production was up 3.7% annualy. The expanded money supply drives interest rates down, causing longer-term production to become more profitable. These indicators show an up-tick in the economy where production takes longer, which is consistent with Austrian Economic Theory.

Bearish Factors:

The Federal Reserve faces political resistance to additional Quantitative Easing. Three Republican Presidential candidates are making comments against the Fed’s actions. While Ron Paul has been a long-time critic of the Fed, the other candidates are taking advantage of heightened public discomfort with the Fed’s monetary policies and resulting price inflation. The recent decision to extend near-zero interest rates for two years was opposed by 3 members of the Fed’s Open Market Committee (FOMC). It has been nearly 20 years since there was such a high level of dissent within the FOMC. Some speculate it will take a large drop in the market (perhaps below 1000 on the S&P 500) to motivate the Fed to initiate QE3. August 26th is Ben Bernanke’s speech at Jackson Hole, which will be watched closely for any hits of QE3.

The argument for QE3 is there are no other buyers able to purchase all of the bonds available at coming Treasury auctions. The thinking is absent any other buyers, the Fed will be forced to step in to prevent a failed auction. We disagree with this premise as there is one other source of funding, and that is the excess reserves. Those $1.6 Trillion Dollars of excess reserves are earning 0.25% interest while on deposit at the Fed. Banks can purchase Treasury bonds at higher rates. Since excess reserves have not yet been fully multiplied by the fractional reserve process, they could fund Federal deficits for several years without additional QE. It was incredibly irresponsible of the Fed to print so much money and we hope they will stop. We also hope they drain these excess reserves. Hope is not a strategy and we have no idea what the Fed will do. The absence of additional QE, while good in our opinion, could be short-term bearish as many market participants appear convinced QE is the only way Treasury bonds could be purchased. This erroneous thinking could motivate selling of equities if the Fed refuses to print more money. Once people realize excess reserves are funding Treasuries, any short-term decline would be reversed.

The Eurozone emergency meetings and political drama dominate headlines. All of the proposed solutions are insufficient stop-gaps and fail to address the structural over-indebtedness of various European nations. As European markets decline, this could continue to have a psychological impact on US market participants in the short-term, preventing US stocks from growing. One very interesting development from the European Central Bank (ECB) was the purchase of €22.0 billion in bonds. While this is not new, it was done without an obvious means of offsetting liquidity. In other words, the ECB might have started to print money. It is not clear if this is a new ECB trend. If the ECB begins printing Euros, that will create inflationary pressure. Price inflation in China, Europe and the US at the same time would be a global inflation unprecedented in the history of the world, and it could be extreme. Initially such inflation would lift stock prices, but over the longer run the erosion of purchasing power will be harmful in real returns even though nominal stock prices likely would increase.

The last item worth mentioning is from Venezuela. President Hugo Chávez announced plans to nationalize the Gold industry. After nationalizing banks, the oil industry, power generation, and telecommunications, there’s every reason to believe Chávez is serious. In addition, the Chávez government has contacted the Bank of England to request transferring their 99 tons of gold back to Venezuela. This could include withdrawing physical gold stored by JP Morgan, Barclays and the Bank of Nova Scotia. All of Venezuela’s nationalized industries suffer declines in output after nationalization, so the removal of Gold and Gold supply from international markets will put pressure on banks. This is bullish for owners of physical Gold. Should the prices of Paper Gold Securities diverge from the spot price of physical Gold, that could induce panic and pressure on banks, which could spread to equity markets. This is a remote possibility right now, but additional withdrawal of physical Gold from banks increase the probability of this happening.

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